What is an Investment Policy Statement (IPS)? An IPS is a client-specific synopsis of the circumstances, objectives, constraints, and policies that govern the relationship between advisor and investor. An IPS should present an investors financial objectives, the degree of risk he or she is willing to take, and any relevant investment constraints that the advisor must consider. Constructing an IPS is a dynamic and often times educational process for the investor. In the end, the process should produce realistic investment goals and ultimately provide the individual investor greater control over his/her financial destiny.

Step #1: Choose an investor (preferably an individual investor rather than an institutional investor such as a pension fund, life insurance firm etc.) Real names do not have to be used to preserve anonymity.

Step #2: Provide a brief background of facts on the investor such as age, number of dependents, occupation, annual income and all sources of wealth, annual living expenses, immediate family members and relationship with them if relevant, personality traits. Include short-term goals, intermediate goals and long-term goals which will require funding. For this project, please focus on one financial objective only.

Step #3: Set a Return Objective the process of identifying an investors desired and required returns should take place concurrently with the discussion of risk tolerance. In the end, the IPS must present a return objective that is attainable given the portfolios risk constraints. It is important to distinguish between a return requirement and a return desire. The former refers to a return level necessary to achieve the investors primary or critical long-term financial objectives. The latter denotes a return level associated with the investors secondary goals (ie. those that if not achieved would not lead to a dire situation for the investor). To calculate an investors required return prepare a two to five year Statement of Cash Flows and a current schedule of investable assets, net worth and calculation of required return.

Establish Risk Objective an individuals risk objective, or overall risk tolerance, is a function of both ability to take risk and willingness to take risk. Ability to take risk is determined by an investors financial goals relative to resources and the time frame within which these goals must be met (time horizon). If the investors goals are modest relative to the investment portfolio (ie. their current wealth), then the greater the investors ability to endure volatility and negative short-term returns. Also, as time horizon lengthens, the ability to recover from intermediate investment shortfall increases. Said differently, longer-term objectives allow the investor greater opportunity to consider more volatile investments, with correspondingly higher expected returns. Willingness to take risk is a more subjective assessment. Psychological profiling can provide estimates of an individuals willingness to take risk, but final determination remains an imprecise science. Consider using one of the risk tolerance evaluations found on the internet (such as: https://retirementplans.vanguard.com/VGApp/pe/PubQuizActivity?Step=start) Considering the aforementioned, rate the investors risk tolerance as either low, average, or high. (example: if ability is high, but willingness is low, then rate as average). Briefly explain the rational for the rating

Identify Constraints IPS should identify all economic and operational constraints on the investment portfolio. Portfolio constraints generally fall into one of five categories: Liquidity, Time Horizon, Taxes, Legal/Regulatory and Unique Circumstances Liquidity: refers to the investment portfolios ability to efficiently meet an investors anticipated and unanticipated demands for cash distributions.

Two factors that should be considered are transaction costs and price volatility. Significant liquidity requirements constrain the investors ability to bear risk. Liquidity requirements can be placed into one of the following categories: ongoing expenses (cost of daily living), emergency reserves and negative liquidity events such as anticipated home repairs or changes in cash needs brought on by retirement. Time Horizon: While there is no universal definition of long-term and short- term most professionals agree that 15 to 20 years is long term and that horizons of 3 years or less is short term. Between 3-15 years is a transition from intermediate to long-term. A second issue relating to time horizon is whether the investor faces a single or multistage time horizon. Other than the elderly, most investors face a multistage time horizon. State whether the investor has a short, intermediate or long-term time horizon and whether the time horizon is single or multistage. If multistage, please identify segments (10 years until childrens college tuition, additional 15 years thereafter until retirement at age 65, and then 20+ years until end of life). Taxes: the issue of taxes is a very individual and complex constraint. Most portfolio managers will seek assistance from a tax specialist when assessing an investors tax constraints. To that end, since this class does not have access to a tax expert, just mention any significant tax events that may result from a future asset sale (ie. selling of low basis stock that may have been purchased years ago or via discounted stock options.) or change in tax bracket. Legal and Regulatory Environment: In relation to individual investors, this constraint most frequently involves taxation and the transfer of personal property ownership. This is another area where portfolio managers will seek assistance from experts such as tax accountants and estate planning attorneys. For this assignment, simply mention any situations that may be present such as personal trusts, family foundations, and gifting desires (children / grandchildren). Unique Circumstances: Include any other constraint in this section. Some examples may be social or special purpose investing, assets legally restricted from sale, directed brokerage arrangements and or privacy concerns (this may dictate the types of buy/sale orders that can be placed.)

Step #6: Asset Allocation given the investors required return, risk tolerance and constraints, suggest an optimal investment policy by allocating assets among Equities, Bonds, and Cash.

Step #7: Justification: Tell me why you chose the asset allocation detailed in Step #6. Format: Steps #1 through 7 can be presented to the class during week #7 via a power point presentation or turned in as a written paper. Please let instructor know by week #5 which format is preferred. Exhibit A Format for Statement of Cash Flows Current Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Inflows: Salary Trust Pension Sale of Securities Total inflows: Outflows: Income Taxes (rate?) Capital Gains Tax (rate?) Living expenses Capital improvements to home Total Expenses Net Cash Flow

Exhibit A Continued Schedule of Investable Assets, Net Worth, and Required Return Investable Assets Amount % of Net Worth Year 1 Net Cash Flow Stock Holdings Fixed Income Holdings Cash Equivalents Retirement Account (IRA) Total Investable Assets Real Estate First Home (net of mortgage) All other (net of debt) Total Net Worth Calculation of Required Return: See Inger Case as a guide. Net Cash Flow for the first stabilized year (i.e. this amount would represent a negative cash flow if investor is looking to the portfolio to satisfy financial goals. Said differently, net cash flow should be after large liquidity events that might be planned for years 1 or 2) divided by Total Investable Assets = X Plus Expected Inflation (use 3%) X + 3% = Required Return